Bailout blues

Lot’s of e-mail on this column so I have posted here for further comment.

Within minutes of it being announced, the $1-trillion emergency rescue package for Europe’s most indebted nations was described as a “shock and awe” bailout by media forever in search of a catchy cliche. In this case, “shock and awe” may turn out to be an accurate modifier for the financial plan worked out by European leaders over the weekend given its association with the U.S. assault on Iraq. The strategy — rapid dominance in military parlance — is likely to produce similar results in Greece as it did in Iraq. The initial onslaught has already succeeded in calming stock markets and easing pressure on bond yields, but the underlying problems that triggered the crisis remain and will persist for years to come.

The rescue package consists of loan guarantees and standby funds that European countries can tap when they are unable to borrow from credit markets, typically due to downgrading by rating agencies that determine their sovereign debt to be junk. Vulnerable nations include Portugal, Ireland, Greece and Spain, derisively called PIGS by their detractors, with Italy in the wings. For months, yields on bonds issued by these governments have been soaring, with the yield on Greece’s two-year notes at a record 25 per cent, and the price for insurance against default (credit default swaps) has reached record levels.

The International Monetary Fund, which is committed to providing about 25 per cent of the funding for the package, is under no illusions that this intervention will solve the problem. Mark Belka, a senior IMF official, told Reuters it was just morphine for the markets.

The purpose of the whole exercise is to prevent a debt crisis that could spawn another global recession. That’s why countries that seem far removed from the carnage are actively involved. Canada, for instance, has lined up a credit facility with the U.S. Federal Reserve to provide up to $30 billion if necessary.

“Canada is not an island,” Finance Minister Jim Flaherty said in explaining the risk of contagion. Although Canadian banks are not overly exposed to European debt, they would be adversely affected if international banks stopped lending to one another.

There are many critics of the rescue plan and they have a point. The beneficiaries of the bailout are not the governments or the citizens of the affected countries. Indeed, there is considerable pressure on these governments to impose austerity measures that will be unpopular, as deadly confrontations in Greece have already demonstrated. Rather, they are the bondholders, mainly French and German financial institutions, that will probably be paid out, with interest. There is a grain of truth to the claim that profits are privatized, losses are socialized.

This is not the way the system should work.

In the real world, Greece, as an insolvent debtor, should have to negotiate an arrangement with its creditors, perhaps extending the amortization of its 10-year bonds to 25 years. Bondholders, meanwhile, should have a risk management plan that mitigates the potential for default. Most, in fact, do. Credit-default swaps are commonly used in this way.

It’s worth noting that life in Greece was sweet. Few paid taxes, most retired on full state pension by the age of 58, and the government has made little effort to attract new industry to boost economic growth. The message the European Union has sent to Greece, and other countries in similar circumstances, is that they will not be allowed to fail.

There is little incentive then for governments that gorged on debt to make politically unpalatable choices if taxpayers from foreign countries continue to let them live beyond their means.

Investors have to take responsibility for the risk they assume, governments have to match revenue and expenditure, and citizens have to surrender their sense of entitlement. Otherwise, this week’s bailout won’t be the last.

“This is not the way the system should work.” Yes, the system — the one called capitalism — is not working the way it ‘should’, the way it would if it was healthy, because it is gripped by serious crisis at its core. This sovereign debt crisis is just the new form that the crisis has taken, now that the ‘great recession’ is formally over. The recession was overcome by government bailouts, and now we have a crisis of government debt. Go figure. The stakes are becoming clearer in all the propaganda emanating from the mass media. Capitalism must be defended, it must be saved from collapse, and we must all do our part, especially, of course, the by far largest part of the population, the working class. In fact, we see enunciations such as: “citizens have to surrender their sense of entitlement.” Why should we, when we know very well we’ve been getting screwed by capital? We deserve far more than what we’ve got, as we are the ones who do all the work in this economy, and we aren’t the ones responsible for this mess. If this system can’t meet our needs and our demands, and it increasingly looks like it can’t, then it stands historically condemned, and needs to be overthrown.

This isn’t capitalism anymore, so let’s just stop pretending. Hopefully the new Icelandic method of fixing the economy; rounding up and arresting all the elitist banker thieves, will spread through Europe and to North America. Maybe then we could try actual market economics, instead of corporatism.

This bailout makes the situation even worse, and when the crash does happen, it will be even more calamitous. What is even scarier is the fact that the situation in the US, when you consider all its obligations and debt, is even worse. The only reason the US economy has been allowed to limp along is because the dollar is the global reserve currency, and the international community has allowed the US PIG to continue its obscenely overextended consumption. Soon this will end and we will see mayhem ensue. Expect a complete collapse of the US dollar via hyperinflation within 5 years. Ultimately, the problem is a result of the fiat paper based monetary system of the world. Dollar bills have no real worth, they are simply pieces of paper printed by central banks. They are actually based on debt. And debt requires interest. Therefore, there must be a yearly exponential increase in the money supply, and to avoid inflation, this requires yearly exponential economic growth. While economists often tout economic growth as a good thing, it is only good in that it allows this fundamentally flawed monetary system to continue. It is not good for long term sustainability, and it is not good for individual consumers who get milked by the system. Of course it is simply not possible to have continual economic growth within the limited confines of the planet. “Real” economic growth in the US stopped well over a decade ago, as its manufacturing industries fled overseas. Instead, the US has been faking its economic growth since then via an steadily decreasing interest rate and maxing out its credit cards to maintain the fiascos for as long as it could. Now, it has simply reached the end of the line. There is no more credit left to squander. The US will fail, and along with this the rest of the world’s currencies. The question isn’t if, it’s when, and what will be the trigger than sparks it. The Wall Street banks are largely calling the shots on that, but even they will lose control at some point.